Perspectives on where our world is heading from a vantage point in Denver, Colorado.

04 October 2010

Angry Bear On Economics

The Economics blog Angry Bear has had some real gems lately:

Debt Financed Dividends

This summer, executives from the New York-based private equity firm SK Capital traveled to Houston to celebrate the first anniversary of their acquisition of a nylon manufacturing business. Soon they will have a bigger reason to uncork the Champagne. The nylon manufacturer has announced plans to issue about $1 billion in debt, of which $922 million will be used to pay a dividend to SK. For SK, which paid $50 million in cash for the business, that is an astonishing almost 18-fold return in a little more than a year.

Apparently, the acquiring firm paid off about a billion of assumed debt when it made the acquisition, replacing it with equity (in which case, what is called a dividend in the story is really a "return of capital" for tax purposes and the return on investment isn't nearly so sweet as the story implies), but switched back to debt because of impending less favorable tax treatment for dividends with the expiration of qualified dividend tax treatment. Still, it certainly looks bad at first blush.

Certainly, the acquired firm is less robust in an economic downturn with $922 million more in debt than it had before this transaction was conducted. The leverage that the debt-equity distinction in the U.S. tax code encourages is a massive source of systemic risk in our economy.

Stimulating Economic Growth

Empirically, the evidence is clear. First, tax cuts do not stimulate economic growth. Second, in a recession, "cutting spending produced worse outcomes than small increases in government spending, and large increases in government spending produced better results still."

It really doesn't matter what you call the economic policy of not cutting taxes during recessions and increasing government spending during recessions. Empirically, this is the approach to public finance that works best.

Who Is Unemployed?

During the current recession, college educated people have had a brief and shallow period of job loss. Those without four year college degrees, in contrast, have experienced a sustained and prolonged drop in employment.

I would discourage jumping to interpretations of the data or policy recommendations from those facts alone with little analysis, however, as the post does.

The superficial conclusion that college educated people have been held harmless from the recession doesn't necessarily follow. College educated people may have lost jobs and may now be underemployed in jobs that would ordinarily be filled by people with less education, in which case both the employed and the unemployed person are worse off than they were before the economic downturn.

It also doesn't necessarily follow that private firms in the economy are doing anything wrong, although that is certainly possible. It could be that private firms collectively simply do not have opportunities to generate enough economic value to cover compensating someone without a college education at a level sufficient for that person to survive in our economy. In other words, they may not have anything profitable that they can hire someone to do.

Government, of course, can't exclude its citizens from its community. The question for government is not, "can I create a job for someone that will generate more economic value than the cost of compensation?" And, ultimately, compensation must be at least sufficient to meet that person's basic needs in our economy if it is to be sustainable without government subsidies.

Instead, the question for the government is, "what can unemployment individuals do that would most contribute to the productivity of our economy?" For the government, putting people to work doing this makes sense even if this is less than the cost of meeting that person's basic needs in our economy. The easiest and most cost effective way to do this may be for government to simply hire people first and figure out what to have them do second.

There may be some cases where it makes more economic sense to simply pay someone a pension than to try to create a job for them. But, often, someone can create value at a government created job that covers a large portion of the value of the compensation that they are being provided, even if it isn't profitable to hire that person. This still increases the size of the economic pie.

It also seems rash to me to conclude that training for less educated workers is not worth it. Training people now creates resources in the economy that are available later when the economy recovers and needs workers for jobs that are profitable. And, in the case of particularly unskilled people, the increase in the economic value of what someone can do may be significant, even if training won't make someone private sector employable without a government subsidy.

The fact that college educated people are remaining employed seems to make clear that having the knowledge necessary to create economic value does matter.